In This Article:
One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. We'll use ROE to examine Singapore Technologies Engineering Ltd (SGX:S63), by way of a worked example.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Singapore Technologies Engineering
How Is ROE Calculated?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Singapore Technologies Engineering is:
23% = S$667m ÷ S$2.9b (Based on the trailing twelve months to June 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each SGD1 of shareholders' capital it has, the company made SGD0.23 in profit.
Does Singapore Technologies Engineering Have A Good ROE?
Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As is clear from the image below, Singapore Technologies Engineering has a better ROE than the average (8.6%) in the Aerospace & Defense industry.
That's what we like to see. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. A higher proportion of debt in a company's capital structure may also result in a high ROE, where the high debt levels could be a huge risk . You can see the 2 risks we have identified for Singapore Technologies Engineering by visiting our risks dashboard for free on our platform here.
How Does Debt Impact ROE?
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.
Singapore Technologies Engineering's Debt And Its 23% ROE
Singapore Technologies Engineering clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 2.15. Its ROE is pretty impressive but, it would have probably been lower without the use of debt. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.